Monthly Archives: July 2017
Bitcoin is something that many people have heard of, but very few understand and even less master. First of all, what is Bitcoin anyway? To make it simple Bitcoin is the first decentralized digital currency. There have been other attempts before to create digital currencies, such as E-Gold in the ‘90s, but they all failed because of their centralized nature that made them fragile. The decentralized nature is the core and most important characteristic of Bitcoin because it doesn’t require a central organization to be trusted (trust is more expensive than what generally people think) and it is censorship resistant. Censorship resistant means that even if your business, the sources of your revenue or your opinions are not approved by the government of your country, your account can not be frozen, and you are still able to fully enjoy your financial freedom sending and receiving payments as you wish.
However, the censorship-resistant is nothing new, we already have another instrument where its users can find the same quality: cash. Therefore Bitcoin can also be seen as digital cash, indeed it can be freely exchanged p2p just like we do every day with coins and notes, so is possible because Bitcoin for the first time ever introduced something that was missing from the digital world, the scarcity. Before Bitcoin every digital file with some kind of value was easily duplicable at close to zero costs (think about all the otherwise quite expensive movies you have downloaded for free), so it wasn’t possible to have a digital asset usable for trades. To make such innovation possible, Bitcoin uses a special kind of distributed shared ledger called blockchain, something that you may have read of on financial newspaper as an object of interest of big banks trying not to get disrupted.
The blockchain is an immutable public database whose identical copies are replicated in thousands of computers all over the world, making the loss or the manipulation of a single copy unharmful. With a powerful accounting tool like the blockchain, it is possible for everyone to track every bitcoin transaction, always knowing exactly which bitcoin is owned by who, without relying on a centralized third party and making double spending impossible. Indeed, if you try to pay two different persons with the same bitcoin, the attempt of double spending would be detected and prevented by the network.
Another even very interesting and unique feature of Bitcoin is his supply model. The only way to produce new coins is through an expensive process called mining, that consist in dedicating a lot of computer power to resolve increasingly difficult maths puzzles, helping to keep the network secure and creating the blocks of data of the blockchain. The mining operations are on purpose very expensive, at the current rate the global yearly cost of mining can be estimated to be around 700 million USD.
Those who dedicate resources to mining are allowed to reward themselves with fresh new bitcoins (i.e. they can send themselves a transaction with 12.5 btc for each block they create), making the monetary base increase. Differently from other currencies, the bitcoin inflation is rigid and keeps decreasing over time, today the total number of outstanding bitcoins in the world is 16 million, with a daily production of 1800 coins per day, but the reward for mining activities will keep halving every 4 years, until the total number of bitcoins created reaches 21 million and no more coins are created. This constriction is obtained with protocol rules, if a miner tries to reward himself with more coins than expected, the other participants of the network will ignore his block and he will lose his reward transaction.
This means that in the long-term bitcoin is deflationary in terms of monetary supply, which is not ideal for some financial operation like loans, but it is the holy grail for store of value. There is no other good in the universe as scarce as bitcoin, not even precious metals like gold and platinum which are expensive to extract with today technology, but with future developments in deep see mining (and maybe even space mining) the supply in the coming decades may drastically change. Bitcoin instead not only is finite by design, but it also has a fixed programmed emission, meaning that an investor knows in advance with extreme precision how many new coins will be created each day.
Some people criticize Bitcoin for being anarchist and risky because it is able to avoid traditional regulation, which is partly true since the transactions cannot be controlled by financial authorities, but actually Bitcoin follows much stricter rules because it is regulated by mathematical constraints, and not by the will of some government agency that may casually change its vision every 4 or 5 years according to the political trends. So, it is true that with Bitcoin nobody can force a reverse transaction to refund and old lady that has been scammed, but at the same time any bitcoin holder is 100% sure to be protected from hyper-inflation.
A huge advantage of Bitcoin as store of value can be found in its extremely low storing costs. While storing and moving gold or other precious metals requires secure vaults and expensive transportation systems, bitcoins storage can be done on small hardware such as a simple USB key or even on a piece of paper and transactions can be sent anywhere in the world in few minutes at a very low cost (about 10 cents). Storing costs and transactions speed are not the only advantages, indeed Bitcoin allows also advance storing options, such as multi-signature accounts. With a multi-signature account it is possible to have funds that are controlled by more people, and a certain number of signatures is required to operate a transaction. For example, it is possible for a company to have an account where the funds are controlled by five members of the board of directors and to create a transaction it is needed at least the signature of the CEO and of other 2 directors, but if the CEO dies or lose access to his signature key, after 6 months three directors out of four remained can send a transaction without the CEO approval.
The success of Bitcoin is not only determined by the amazing features it has, those are easily achievable also in other cryptocurrencies. What gives Bitcoin a competitive advantage is the network effect, the security and the usability of a cryptocurrency is obtained by having a lot of participant in the network and a lot of economic interests running on it. This means that even if a technological more advanced alternative is found, a new user will always have an incentive to join the Bitcoin network instead of something else, making it even more secure and usable.
The proprieties and use cases described above are just some of the most immediate and market ready applications of the blockchain, but another very important point is that for the first time ever Bitcoin allows computer programs to trigger financial transaction without need of human permission. While some people may still find Bitcoin non-intuitive and its application not very user friendly, for machines it’s just perfect since they can actually manage money autonomously. If the IoT industry really becomes a thing, different devices will have to pay each other for goods and services, in such scenario an old fashion financial system could cause friction. Thanks to Bitcoin we could have a future where an autonomous vehicle earns its own money with a Uber-like service and can autonomously pay for fuel, maintenance, insurance and even a dividend to the owner.
Bitcoin is bringing us many innovations, but knowing just few of them is already enough to understand how valuable it is a know-how in this technology.
Federico Tenga, Co-Founder at Chainside